ABSTRACT
The theories presented in previous chapters assumed that goods were internationally mobile and factors of production were internationally immobile. Before trade, the labor-abundant country had a relatively lower wage rate than the capital-abundant country. Through trade, wage and rental differentials disappeared. If country A is labor-abundant and country B is capital abundant, before trade labor in country A is relatively cheaper than labor in country B. Country A exports the labor-intensive good, causing an increase in the domestic price of this good. The wage rate in country A also increases while the rental rate for capital declines. Country B exports the capital-intensive good, causing the domestic price for this good to increase. The rental rate for capital rises and the wage rate falls. Through trade in goods, differentials in factor prices diminish. The identical result occurs when trade in goods is prohibited (through the use of a tariff, for example) but factor mobility is allowed. When labor and capital are internationally mobile, abundant labor in country A would migrate to country B because of the higher wage. As labor flows from country A to country B and capital moves the opposite direction, the wage rate in A increases as labor becomes scarce. Capital would move from country B, where its abundance generates a low return, to country A, where its scarcity yields a higher return. In other words, international mobility of factors also generates an equalization of prices.
